Tag: Spotify IPO Watch

However–Spotify is a particularly interesting stock for a number of reasons, mostly having to do with the nature of the initial offering. Remember, Spotify did not offer shares in an “initial public offering,” they used an untried method called a “direct public offering.”

The difference is crucial. In an IPO, or as it’s more precisely known, a “full commitment underwriting,” the company (or “issuer”) actually raises money through selling new shares of stock to a group of investors, usually banks. These investors are often called “underwriters”. In the case of a full commitment underwriting IPO, the company sells shares to an underwriting group (or “syndicate“) and the syndicate then sells those shares to the public after the syndicate decides the valuation of the company and the price of the shares of stock.

This is completely different from the direct public offering. There are no new shares, there is no syndicate, and the price is set (or was for Spotify) by reference to the price of shares selling in the private market immediately before the public is able to buy–and my bet is that the DPO price was a lot higher than an IPO price would have been. (Dropbox, for example, priced at $21 and closed at $28.48 on its first day of trading. Facebook priced at $38, Google at $85, Alibaba $68, Amazon was $18. All had different valuations, of course. Spotify priced at $132 using a loophole from the SEC. And what goes up, must come down.)

So, you may ask, if the issuer doesn’t sell shares to an underwriting syndicate, where do the shares come from?

The shares come from insiders at the company and any other shareholder, employee, record company, other investors already holding shares who want to get out. All of these insiders have an incentive to keep the share price as high as they can before they get their shares sold to the bigger fool…sorry, I mean to other investors.

According to a puff piece that Spotify’s lawyers conveniently wrote and published at a Harvard Law School meeting (wonder who paid for that), Spotify identified three goals in their DPO:

Offer greater liquidity for its existing shareholders [translation: existing shareholders can cash out], without raising capital itself and without the restrictions imposed by standard lock-up agreements

That last one is utter gibberish as the SEC takes care of the transparency through Form S-1 (or F-1 in Spotify’s case as a foreign filer) and Regulation S-K. The first point is really two related but different goals: lockup agreements bar employees and key holders from dumping their stock for a typical 180 day period. This is to avoid high employee turnover after a public offering the way we’ve seen at companies like…you know…Spotify. It’s generally thought that losing key employees is bad for shareholders, so that’s why every mother’s daughter has lock up agreements. It’s also hard to recruit replacements when the insiders are selling, especially if the stock is tanking.

And one can’t help noticing that building a sustainable business model for long-term shareholder value and artist longevity is not on the list.

Anyway…if you look at the following chart, you’ll see some interesting patterns developing over the short history of Spotify’s stock. I don’t put a lot of trust in chart analysis, but some people do and it is one of the few things we have to rely on in this case because there is so much insider activity.

You’ll notice that there’s something of a “head and shoulders” pattern emerging when the stock reached its high on July 26, 2018 of $196.28. This pattern is often associated with a move to the downside, sometimes a sharp move to the downside.

Sure enough, the stock went into a sputtering dive the next day and the dive has continued ever since. Note that at the high, volume was rising. The low volume of Spotify stock is another one of the untold stories and is another suggestion of price management in the background.

Once the downside move became apparent, which was about October 10, downward pressure accelerated on rising volume (relatively speaking since volume is low). A couple weeks later, more sell signals confirmed the downside move.

One signal that I found significant was the 50 and 100 day moving averages of the stock price crossed to the downside on October 22, which also happened to be the date that the stock traded and closed at $148.54–below $149.01, the closing price on the first day of trading.

Starting with the high at the head and shoulders formation, the stock has more or less collapsed on about a 45 degree downward angle ever since. Why is that? Possibly because the stock was priced too high to begin with. Some people think that SPOT is just reacting to the overall market sell-off. I don’t think that is true as SPOT has not moved in relation to the market since inception. SPOT was higher on the market highs and lower on the market lows, so I don’t see the coupling argument at all.

Plus, Spotify announced a $1 billion stock buy back, so the price is rapidly declining in spite of the buyback. Perhaps if Spotify had made a tender offer for shares at a fixed price, they could have supported the stock more successfully.

Based on the stock’s recent history, it would not be surprising to see SPOT retrace some of its collapse and rise to something in the $120-$130 range by the end of the year. Then I suspect that it will decline to approximately $95 around the end of January.

After that, we shall see. Obviously, this is not investment advice, just speculation based on some guesses derived from the chart. But the chart is relevant because there’s unlikely to be any real change in the company’s financial position in the next six weeks.

Like this:

Stocks go up, stocks go down, what does it all mean? In the very recent declines of the stock price of credible companies, you saw them punished for good quarters but guiding lower. Even “big tech” stocks like Google and Amazon were punished for revenue misses and cloudy guidance.

What’s happening with the Spotify stock price? I would argue the main downward driver for SPOT is much more straightforward–the market is simply catching up to the Spotify DPO and its insider-heavy stock sales. We won’t really know the hard numbers on insider trades until the SEC starts making those insider Form 4 sales more easily available online. That should should happen any day now (and none of the mainstream music industry publications seem to be interested enough in the the truth setting them free to actually dig through the SEC Form 4 filings at the source).

But–there could be enough shares out there in the marketplace that SPOT may be starting to trade like an IPO as opposed to an insider cash-out (or DPO). And once the market really becomes part of the Spotify trading day and trading volume increases, a few things start happening. One is that as more shares are held by the public, there are an increasing number of shares available to allow the “buy high, sell low” short trading that can cause big swings in a stock’s price due to short covering if nothing else.

SPOT also starts to become more susceptible to the other stocks in its cohort as more retail investors have to answer the question, what will I sell to buy Spotify? The answer will be different for different people, but if there are more sellers than there are buyers, we know what happens. That’s why the majors, Sony in particular, were very smart to start selling their holdings almost immediately.

What would you sell to buy Spotify? Probably not its competitor Apple–whose shares trade almost opposite to Spotify on a relative basis.

SPOT-APPL 11-1-18

If you’re looking at the performance of SPOT, you have to ask yourself what about this chart says “buy”?

SPOT 50 and 100 Day Moving Averages 10-31-18

You have a stock that’s broken through both its 100 and 50 day moving averages to the downside as of yesterday, and so far in today’s action is testing lower lows. And not surprisingly sank like a stone following a “head and shoulders” top technical chart pattern indicating a potential bearish trend that has now been confirmed (as I began watching in June on Music Tech Policy before the stock gave up almost $50 of its share price).

I guess the MMA safe harbor is priced in.

Keep asking yourself that question: What would I sell to buy SPOT? If you’re not an insider, that question will eventually guide you (and the market) to the right share price. That will have nothing to do with Spotify’s royalty payouts, how many floors of World Trade Center it rents, or competition with YouTube or Apple. Don’t let the analysts (or the company) fool you–although some analyists are starting to face the Spotify reality.

That will be–I would suggest–a problem with the insider-controlled Direct Public Offering structure and the SEC’s decision to allow Spotify to price at a meaninglessly high number. What goes up on fantasy comes down hard on reality.

Like this:

Is Spotify’s unusual “DPO” approach and bizarre $132 selling price simply a way for insiders to short the stock? See SPOT run! Run SPOT run!

Here’s an interesting anecdote about that imminent Spotify stock offering. Remember, Spotify is rumored to price at $132 per share based on private market trades (on a split adjusted basis, I guess).

If the Spotify “DPO” actually does trade at $132, it will probably be the highest valued IPO stock ever. Dropbox, for example, priced at $21 and closed at $28.48 on its first day of trading. Facebook priced at $38, Google at $85, Alibaba $68, Amazon was $18. So Spotify will have to be pretty special to actually trade at $132 on the public market.

It’s good to remember that most of these comparisons had what’s called a “full commitment underwriting” where the company issues new shares that are purchased by an underwriting syndicate and then resold to the public. Spotify will issue no new shares. So–one would surmise that the only ones selling will be those who already hold Spotify shares that have been allowed to be sold on the public exchange. That appears to mean the shares that will be trading will be the insiders (or mostly the insiders), with no restrictions on which of those insiders can sell on the first day of trading. (Most IPOs have a restriction (called “lockup agreements”) on when employees can sell their shares to avoid a rush for the exits.)

I happened to be chatting with two sophisticated investors in recent days, one from a hedge fund and the other an entrepreneur who has taken a couple companies public. Both of them had the same reaction after we talked through Spotify’s competitive position and some of the disclosures in Spotify’s SEC Form “F-1”.

Let’s start with Spotify’s description of who it counts as a subscriber:’

We define Premium Subscribers as Users that have completed registration with Spotify and have activated a payment method for Premium Service. Our Premium Subscribers include all registered accounts in our Family Plan. Our Family Plan consists of one primary subscriber and up to five additional sub-accounts, allowing up to six Premium Subscribers per Family Plan subscription. Premium Subscribers includes subscribers who are within a grace period of up to 30 days after failing to pay their subscription fee.

If you think that a paid subscriber means a subscriber who paid, you’re probably not wild about this definition, and both my friends thought it was not only a meaningless number but also was deceptive. My guess is that it conservatively overstates “Premium Subscribers” by about 20% given the number of freebies that Spotify hands out. We were all actually surprised that the Securities and Exchange Commission allowed Spotify to get away with this kind of disclosure as the definition is buried in a footnote. Neither friend had noticed it, and these were people who are too smart to miss these things normally.

Then there was a discussion about that New York real estate–Pandora is certainly learning its lesson about sky high overhead and is migrating gradually to Atlanta. I’ve always been mystified why money losing companies like Spotify get away with locating in some of the highest priced real estate in the world–San Francisco and Manhattan. And also get away with complaining about royalties instead of rents. Rather than the labels rewarding them based on subscribers, why not reward them based on subscribers if and only if they also lower their overhead (called SG&A) by a certain percentage.

Both conversations ended with a discussion of the 10 second MBA–buy low, sell high. This is what you do with a long position in a stock. In Spotify’s case, we were discussing another kind of position, a short position. Short selling reverses the equation–buy high, sell low.

This is because the short seller is betting that the stock will trade lower, and usually considerably lower, than the price at the beginning of the short seller’s round trip. In brief, what happens with short selling is that you borrow the shares from someone who holds them. You get to borrow them for a fixed period of time. You then sell those borrowed shares at the then-current market price.

Because your bet with “directional” short selling is that the shares will decline in value over time after that initial sale of the borrowed shares, you then essentially use the proceeds from the sale of the borrowed stock to purchase the shares before your short period expires. You then return the borrowed shares after you buy them back.

Sometimes you can make a fortune selling short (which doesn’t require shorting stocks, see George Soros shorting the UK pound stirling and The Big Short). Of course, it can go the other way, too, and result in a short squeeze if the price of the shorted stock increases and short sellers have to “cover” at a higher price than they sold the borrowed shares so they can return the borrowed shares and not default.

“Short interest” is a published number and can be used as a measurement of market sentiment about a particular stock. It’s the aggregated number of shares of a stock that have been sold short but haven’t been closed out or “covered.” (Similar to the “put to call” ratio in options trading.) So it was a bit remarkable to me that both these friends said they’d probably short Spotify as soon as they could.

That’s an interesting question–when could the Spotify stock be shorted. In order to short, there must be some inventory of shares available to borrow and trade such as from a brokerage house (who can lend the shares from clients’ margin accounts, for example). Typically, underwriters of an IPO are not allowed to short their IPO stock for 30 days or so. However, there is no such restriction on retail investors–and Spotify has no underwriters.

Therefore, there may be no restriction on when the Spotify insiders can short Spotify stock.

And if my anecdotes are any guide, it certainly does look like there will be a market for short sellers. One could even say that insiders seeking to short Spotify shares are simply acting prudently to protect their downside, not unlike a “collar” or other hedging transaction. This will be particularly true if there is a real run on the exits and early investors or other holders (like the senior management team) start selling right away given they have none of the usual lockup agreements or restrictions on trading as far as I know.

In the words of one of the friends, the shorting will begin at 9:31 on the first day of trading. As someone who knows the importance of a few seconds in the world of automated trading, I believe him.